Concerns over ILS models raised at SIFMA
The growth of the insurance linked securities (ILS) markets could be good for the insurance industry as a whole but some concerns remain around the risk modelling used by these deals and standardisation of documentation in the market could be improved.
Those were some of the key talking points of some of the panel discussions that took place at the SIFMA Insurance and Risk Linked Securities conference in New York this week.
Samir Shah, senior vice president and chief reinsurance officer AIG Property Casualty, said while the insurer felt it did not need to enter the market directly it had a long term interest in securing its growth. “When we lower the cost of risk, the insurance volume goes up, so different communities and regions benefit,” Shah said.
Peter Nakada, managing director of life risks and capital markets at Risk Management Solutions, said cat bonds make the transfer of cat risks more efficient. “Having large chunks of risk with reinsurers wasn’t efficient; having cat bonds in the mix helps. We don’t want a small handful of people controlling how risks are priced,” he said.
John DeCaro, founding principal and portfolio manager at Elementum Advisors, added that the liquidity of the market is also very attractive. “The liquidity offered through the option to buy and sell often is very appealing. Even after Sandy there was still liquidity in the market and it was still functioning.”
But several speakers also voiced concerns about uncertainty around the payment of claims and the process of risk analysis.
“Despite being perfected for the last 17 years, my concern would be that a technicality within the document may cause a delay in getting paid,” said Shah.
“My other concern is over the risk analysis. AIG uses hundreds of people to analyse the risk, then input these risks into model and analyse them again before deciding on an input. In the bond market, we’re told to pick one model, which we have to pay to licence and pay more to receive that independent third party review, but really they’re running a model that we use every day.
“Inevitably we’re always getting told that we’ve selected the wrong risk, so recently we gave our data to all three cat modellers and got them to analyse it and offer investors their view on it.”
Panel moderator, Judy Klugman, managing director and head of ILS distribution at Swiss Re Capital Markets, agreed that giving data to a selection of modellers is a good idea, but reminded the audience that no one expects the money managers to be underwriters.
“We don’t expect the money managers to be underwriters, so it’s hard to expect them to pay for the models for risk analysis,” she said.
DeCaro agreed: “The whole point of the bond market is to disperse risk. We don’t want cat bonds to move to an underwriting perspective. Fundamentally the market works well as it is – it doesn’t make sense to model everything.”
The lack of a single standardised cat bond document was also raised as an issue, with Michael Madigan, a partner at Sidley Austin, noting that on many deals what he described as ‘nice to have’ clauses are often written in on a bespoke basis.
“The real question needs to be ‘is this really necessary?’” said Madigan. “It creates complexity and takes time to implement, which in turn means higher costs.”
